‘Dreaded conflict’ for the Fed: slower growth and faster inflation

The numbers coming out of the Commerce Department on Thursday morning weren’t on their face alarming for the Federal Reserve, but they certainly didn’t make lives any easier — inflation is heating up while consumer spending seems lackluster. The PCE measure of inflation rose to 1.8% year-on-year — getting closer to the central bank’s 2% target — while consumer spending rose just 0.2% on the month to take the year-on-year move to 3.7%.

“This report seems to present the Fed with the dreaded conflict between its objectives: slower economic growth but faster inflation,” said Mike Moran, chief economist at Daiwa Capital Markets America.

More from Moran:

We suspect that Fed officials will be mildly concerned, but not alarmed, about recent developments. Consumer spending has hit an air pocket, but with the job market improving, activity should pickup. In addition, officials expected the rate of inflation to increase this year. The pickup has no doubt been much quicker than they anticipated, but the direction of change was expected. We suspect that the apparent conflict will lessen as time passes – consumer spending and economic activity will improve from the recent pace, and inflation will not continue to accelerate. If not, Fed policy will have to deviate from the expected path of gradual tightening beginning in mid-2015.

Lindsey Piegza, chief economist of Sterne Agee, had an even more pessimistic view.

Following yesterday’s outsized downward revision to first-quarter GDP, this morning’s consumption report does little to reinstate confidence in a near-term bounce in growth. After growing at the weakest pace in five years, consumer spending appears to be on a similar 1-1.5% trajectory in Q2. Many economists calling for a surge in spending because of pent-up demand created in Q1, have thus far been severely disappointed.

The MarketWatch consensus for second-quarter growth now stands at 3.6%, following the 2.9% contraction in the first quarter.